Market surge indicates a disconnect with economy
Investors are piling into stocks, shrugging off worries about rising Covid-19 infections and betting on a speedy economic recovery, even as a steady stream of data points otherwise.
If India’s fear-gauge, the India volatility index (VIX), is any indication, the panic over the pandemic and its fallout on the economy is officially over. The index has cooled off sharply from the March highs during the market rout and is hovering around a six-month low. It has plunged 76% from the highs of 86.64 touched on March 24 when stock indexes crashed more than 10% in a single day. A fall in the VIX index indicates investors’ fear about a sell-off in equities is ebbing.
The index’s movement is in sharp contrast to India’s economic fundamentals and earnings growth. Economists are predicting GDP to shrink between 5% and 9.5% this year, the biggest contraction since Independence. Yet against this bleak backdrop, Indian stocks have gained 50% from the lows in March. With an enormous amount of liquidity sloshing around the global financial system, investors are disregarding the seeming disconnect between stock prices and corporate earnings.
“There is so much liquidity in the system, in the global economy; that’s why the stock market is very buoyant and it is definitely disconnected with the real economy. There will definitely be a correction, but we can’t say when,” Shaktikanta Das, governor, Reserve Bank of India, said in an interview. Low volatility reflects confidence among investors that there won’t be a deep sell-off, even as markets are 8-9% off the record highs in January.
Analysts said investors’ perception of risk is falling as equities are gradually rising from record lows in March this year.
“The significant decline in the VIX can be attributed to complacency in the market to some extent,” said Gaurav Ratnaparkhi, a senior technical analyst at Sharekhan by BNP Paribas. One of the key reasons fuelling the current rally is gushing foreign portfolio investment inflows into India fuelled by low-interest rates in economies such as the US, where the cornerstone of monetary policy is to keep pumping liquidity to keep the securities market from collapsing.
Analysts said the risk-reward calculation for Indian stocks is turning unfavourable and foreign liquidity is critical to keep the rally going. “While FII (foreign institutional investor) inflows in August have been robust, net institutional flows could slow down as markets may consolidate near term since large sectors led by financials await clarity on quantum of NPAs and loan restructuring and IT, telecom, pharma sectors now offer limited room for upside,” said analysts at BofA Securities in an August 19 note.